Opinion: Stock market is ‘oversold,’ but worth staying bearish

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The stock market returned to an extremely bearish phase, as it hit new yearly lows. This pattern of lower highs and lower lows in stock prices defines a bear market. For this reason, a “central” bearish position should be maintained.

Recent activity in early October had offered potential hope for bulls as oversold conditions in the S&P 500 SPX,
+2.42%
have become buy signals in a few cases. These have however been negated by this latest return to new lows, and so it is back to the drawing board in terms of setting new buy signals from lower levels.

Not only has SPX made new lows, there is now a third island inversion on its map (the circles on the SPX map above). These are rare for an index chart and are quite bearish.

The first major resistance zone is at 3700-3750 points, which is the first gap on the chart (created when the third island reversal formed). As for support, you have to go back to the fall of 2020 to find prices this low, and when support is this old, it’s tenuous at best. There is theoretically support near 3500.

The McMillan Volatility Band (MVB) buy signal is still in place (green “B” on the chart), and it would be stopped if SPX closed below the “modified Bollinger Band” of -4σ.

Equity-only put option ratios reach new highs in 2022, reaching levels last seen in March and April 2020. This makes them oversold, but still on sell signals. Buy signals would only form if they reversed and started falling. It appeared they were doing it in early October, but that was called off when they hit new yearly highs. Also total The put-call ratio is at new highs, so it hasn’t generated a buy signal yet either.

The width of the market has been extremely negative, so both width oscillators remain on sell signals. They are in oversold territory, of course, but that does not mean that the market should be bought on this basis. You have to wait for confirmed buy signals, which will not happen here right away. It will take two or three days of positive width to roll these oscillators to buy signals.

New highs on the NYSE were just eight yesterday, so the “new highs vs. new lows” indicator remains mired in a sell signal, as it has been since April.

VIX slowly pushed higher, though it had not reached a new high for the year. Even so, the orient oneself The VIX sell signal remains in place and will do so as long as VIX continues to close above its 200-day moving average (MA). This MA is at 26 and rising, so VIX is well above it.

On a perhaps more positive note, another VIX “peak” buy signal is setting in, as VIX “climbs” higher. This buy signal will occur when VIX closes at least 3.00 points less than its highest price. So far, the highest price reached in this most recent move is 34.53 on October 12. Somewhat surprisingly, SPX had sold off heavily earlier on Thursday on the CPI numbers, but VIX was basically unchanged.

The construction volatility derivatives has been slightly negative over the past few weeks. That is, the term structures of VIX futures and CBOE volatility indices have a downward slope at the front of the “curve”. So far, this has not reached levels that would be considered major sell signals, but it is still negative to see October (first month) VIX futures trading above the price of November VIX futures contracts.

In summary, we continue to hold a “basic” bearish position and will trade confirmed buy signals around this if and when they occur.

New recommendation: Potential buy signal “VIX crossover”

VIX has been trading higher than VIX3M in recent days. This is an inversion of the term structure of the CBOE Volatility Indices and represents an oversold condition. When it returns to normal, a buy signal occurs. Simply put, when VIX closes below VIX3M, it is a short-term buy signal that typically produces its best results in the first five trading days.

IF VIX closes below the price of the VIX3M,

THEN Buy 1 SPY Nov (18e) call for parity

And sell 1 SPY Nov (18e) call with a strike price 20 points higher.

Once the position is established, stop if VIX closes above VIX3M for two consecutive days. Otherwise, exit the position after five trading days.

New recommendation: Potential VIX “spike” buy signal

These signals have not been successful recently, but have been quickly halted. The blue “B”s on the VIX chart above indicate losing trades. However, this trading system has a long and successful track record, so we will continue to use it.

IF VIX closes at least 3.00 points below its most recent high on October 12e and then,

THEN Buy 1 SPY Nov (18e) call for parity

And sell 1 SPY Nov (18e) call with a strike price 20 points higher.

If established, we will hold it for 22 trading days (approximately one month). Stop if VIX closes above this “most recent high” price.

Follow-up actions:

All stops are mental closing stops unless otherwise stated.

We use a “standard” rolling procedure for our SPY spreads: in any bullish or bearish vertical spread, if the underlying hits the short strike, then roll the entire spread. It would be rolling at the top in the case of a call bull spread, or roll down in the case of a bear put spread. Stay in the same exhale and keep the same distance between strikes unless instructed otherwise.

Long 1 SPY October (21st) 377 puts and shorts 1 SPY Oct (21st) 347 set: this is our “basic” bearish position. Previously it was twice rolled down 30 points on each stroke (in accordance with our general “rolling” rule stated above). Since it is now 20 points in the money on the long put options and the expiration is only a week away, lower and close the entire spread: sell the spread you currently own and buy November 1 SPY (18e) put and sell at parity 1 SPY Nov (18e) put with a striking price of 30 points less. NOTE: If there is Nope hit 30 points lower, then use the nearest 30 points lower.

Long 6 CANO Oct (21st) 7 calls: volume of options in CANO rose again, riding the momentum of rumors of possible takeover interest by SVC, HUM and others. A Citi analyst recently estimated a possible takeover price as high as $14 for CANO. Raise the stop at 8.25.

Long 2 BFB October (21st) 65 put options: since BFB was trading at 65, we went down to the October (21st) 65 put options, as instructed in last week’s report. We will hold these puts as long as BFB’s put-call ratio is on a sell signal.

Long 1 SPY October (28e) 391 and Long 1 SPY October (28e) 366 set: it started like the long 391 climb over; then we rode on October 28e) 391 set to oct (28e) 366 bets. Keep holding on non-stop for now. Roll again if SPY trades at 346.

Long 1 SPY October (28e) 377 puts and shorts 1 SPY Oct (28e) 352 set: this spread was purchased in accordance with the VIX trend sell signal. stop if VIX closes less than 25 for two consecutive days. This spread is also 20 points in the money, so lower both sides by 20 points, staying in October 28.e expiry.

Long 1 SPY October (28e) Call 372 and Short 1 SPY Oct (28e) call 387: this gap was bought in line with the $VIX “spike peak” buy signal. VIX went back into “doping mode” on October 10e, so the spread should have been taken out at that time. If you haven’t, exit now.

Long 1 SPY November (18e) Call 376 and Court 1 SPY Nov (18e) Call 396: this is the new MVB buy signal, which was established on the morning of October 4e. The goal of this trade is for SPX to trade in the upper +4σ band. The stop for this position would be if SPX were to close below the -4σ band.

Long 5 HLIT Oct (21st) Calls 12.5: stop on a fence below 12 by HLIT.

Send your questions to: [email protected]

Lawrence G. McMillan is President of McMillan Analysis, a registered commodity trading and investment adviser. McMillan may hold positions in securities recommended in this report, both personally and in client accounts. He is an experienced trader and money manager and is the author of the bestselling book, Options as a Strategic Investment. www.optionstrategist.com

Disclaimer: McMillan Analysis Corporation is registered with the SEC as an investment adviser and with the CFTC as a commodity trading adviser. The information in this newsletter has been carefully compiled from sources believed to be reliable, but its accuracy and completeness are not guaranteed. Officers or directors of McMillan Analysis Corporation, or accounts managed by such persons, may hold positions in the securities recommended in the advisory.

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